Definition
Common stock represents your ownership in the company. These rights/power include an appointment for the board of Directors, formation of the board policies, and other matters related to business management.
There are two important aspects of the common stock that include voting rights and the share of profit. The voting rights are used to make decisions related to board management and other critical matters for the business.
Although, investment in common stock brings significant returns. However, it’s accompanied by higher risk. For instance, if the business goes into the liquidation, the holders of common equity only get assets if something is left after paying for the debt holders, and preferred shares holders. Hence, there is more risk in investing via common stock than investing via debt.
Explanation
Generally, businesses have two options to raise finance. One of the options is equity financing and another option is debt financing.
Equity financing is done by issuing common stock of the corporation. In simple words, it’s the receipt of the funds by selling business ownership. For instance, if the value of your business amounts to $100,000, a 10% stake can be sold for $10,000. On the other hand, debt financing is raised by issuing bonds, debentures, loan notes, commercial papers, deposit certificates, and other instruments.
The trading for the common stock takes place via a stock exchange. Countries around the globe have a stock exchange where trade takes place for the shares. For instance, stock exchanges in the USA are NASDAQ and New York Stock Exchange. When the company gets listed at the start, they issue shares via IPO – Initial Public Offering.
How common stock is traded on the stock exchange?
Shares are sold and bought via the stock exchange. The prices of the share price fluctuate depending on the demand for shares. For instance, if the market is optimistic about specific shares, its demand increases and leads to an increase in price. Further, the market may feel optimistic about shares in different situations. These situations include but are not limited to the following.
- Higher company profitability.
- The market thinks the share price is currently undervalued.
- Some positive news in the market about the company.
- Overall enhancement of the economy.
On the contrary, if the market is pessimistic about the performance of a company, they tend to sell the securities. Hence, supplies of the specific security increases leading to a decrease in share price.
Alternatives of investing in the common stock
Investing in the common stock requires an understanding of the business environment, market dynamics, business performance, market signals, current share value, and many factors. So, it may not be a cup of everyone’s tea to select appropriate investing securities. Hence, the following options can be a good idea to further explore.
- The investment can be made in mutual funds. It relieves investors from actively managing the investment portfolio. Further, setting investment strategies and diversification matters is the responsibility of the fund manager. Hence, an investor does not have to actively manage the investment portfolio.
- An investment in the ETF can be another good idea. Mostly, the value of an ETF is driven by the index. So, if an index moves up, it’s increased. On the other hand, if the index moves down, it’s decreased.
- Investing in bonds can be another good idea. The risk of investing in bonds carries a lower risk of default and lower return on the investment.
Accounting / Journal entry for issuance of common stocks
The following journal entry is passed when the company issues stock at PAR. For instance, ABC Co issues 10,000 shares at the rate of $1 per share. The following journal entry can be posted in the accounting system.
Common stock journal entry example
Following journal entry is passed when common stock is issued at PAR.
| Particulars | Debit | Credit |
| Cash | 10,000 | |
| Common stock | 10,000 |
The debit impact of the transaction is the receipt of cash. The amount has been received by issuing security or diluting the ownership stake. On the contrary, the credit impact of the transaction is recorded for the equity balance.
Accounting / Journal entry for issuance of common stocks at premium
The following journal entry is posted in the general ledger when the company issues stock at the premium. For instance, ABC Co issues 10,000 shares at a PAR value of $1 per share and a $0.5 premium per share. The following journal entry can be posted in the accounting system.
Common stock with paid in capital journal entry example
| Particulars | Debit | Credit |
| Cash | 10,000 | |
| Common stock (10,000 x 1) | 10,000 | |
| Paid in capital (10,000 x 0.5) | 5,000 |
The debit impact of the transaction is the receipt of the cash. This balance is received in line with the issue of equity. On the other hand, the first credit records were capital issued at PAR. Similarly, the second credit in the above transaction reflects the credit impact of the amount received over and above the PAR value of the common stock.
Accounting / Journal entry for issuance of preferred stock
The basic accounting for posting preferred stock is the same as common stock. Following journal entries can be posted in the accounting system.
| Particulars | Debit | Credit |
| Cash | XXX | |
| Preferred stock | XXX | |
| Additional Paid in capital | XXX |
The debit impact of the transaction is the receipt of the cash against the issue of the preferred shares. On the other hand, the first credit is recording for the preferred stock. Similarly, the second credit is to record capital received over PAR value as additional paid in capital.
For instance, the corporation receives $12,000 as cash by issuing preferred stock (10,000 preferred stock at a price of $12, the PAR value for the preferred shares amounts to $10 and an additional $2 is received as additional paid in capital).
So. The following journal entry can be posted in the accounting ledger.
| Particulars | Debit | Credit |
| Cash | 12,000 | |
| Preferred stock | 10,000 | |
| Additional Paid in capital | 2,000 |
Common stock vs. preferred stock
Following are the differences between common stock and preferred stock.
| Common shares | Preferred shares |
| These shares carry voting rights. It means the common shareholders can make a decision regarding strategic and operational matters of the company. | These shares do not carry voting rights. It means the holders of the common shares are not involved in the decision-making process. |
| During income distribution, these shareholders are paid once preferred shareholders have been paid. They stand second for collection of the income/profit. | During income distribution, these shares are preferred for payment of the dividend. Hence, these shares are called preferred shares. |
| In case of liquidation, the common shareholders of the business are stand last in line for claim over assets. Debt instrument holders and the preferred stock holders are given preference. | In case of liquidation, the preferred shareholders are given preference for the distribution of assets. |
| These shareholders are not given a guarantee for the dividend. | Generally, these shareholders are given a guarantee for the dividend/interest. So, it’s similar to the bonds and other debt instruments. |
Accounting / Journal entry for service rendered
Sometimes, the business might issue common stock against services received or services rendered. In this case, there is a need to assign a certain value to the service (Monetary value). So that, accounting entry can be recorded as follows.
| Particulars | Debit | Credit |
| Organization cost | XXX | |
| Common stock | XXX | |
| Additional Paid in capital | XXX |
The given set of transactions can be recorded with the following example.
For instance, ABC startup has received attorney services amounting to $30,000 and agrees to pay this amount via an issue of equity. The equity to be issued amounts to $3 per share ($2 is PAR value and $1 is above PAR). The following journal entry can be posted.
Accounting / Journal entry for service rendered
| Particulars | Debit | Credit |
| Organization cost | 30,000 | |
| Common stock (2×10,000) | 20,000 | |
| Additional Paid in the capital (1×10,000) | 10,000 |
Accounting for treasury stock transactions
Sometimes, the companies have excess cash resources and a lack of projects to invest in. Hence, they feel feasible to reduce their share capital. In this case, these companies can recall their own shares from the market. These recalled shares of the company are called Treasury shares.
The accounting format for the treasury stock is as follows.
| Particulars | Debit | Credit |
| Treasury stock | XXX | |
| Cash | XXX |
The debit impact of the transaction is the reduction in the share capital. Since it’s a recall of the shares. On the other hand, credit impact leads to a decrease in cash. The balance of treasury shares is shown as a contra account in the capital account after retained earnings.
Likewise, the companies can reverse treasury shares and once again raise finance by issuing these shares in the market. The journal entry is reversed in this case.
Frequently asked questions
What is the issuance of common stock?
Issuance of common stock means the company sells its ownership. Generally, common stock is issued at PAR along with premium. The cash received against PAR value is classified as common stock and the cash received over PAR is classified as additional paid in capital.
How to record stock issuance?
Stock issuance is recorded with the following journal entry.
| Particulars | Debit | Credit |
| Cash | XXX | |
| Common stock | XXX | |
| Paid in capital | XXX |
Why do companies buy back their own shares?
The companies buy back their own shares when they feel their share price is undervalued because of an excess supply in the market. Companies decrease the supply of their shares to restore share price. Likewise, companies may have excess cash and not feasible projects to invest in. Hence, companies buy back their own shares.
